For the first time, investors have an opportunity to own a utility company that focuses on one highly specialized area of the business, one that has a built-in regulatory hedge against losses.
ITC Holdings (ITC) is the nation's largest independent electricity transmission company. It owns and operates four separate transmission-line systems. Today, its lines move bulk power between midwestern utilities. In the next several months, its reach may include Texas and several southern states.
It is important to understand ITC's business, because transmission lines are very different from distribution lines. Transmission lines move bulk power over long distances. Because they use high voltages, their transmission of power is efficient and cost effective. Transmission lines feed power to local distribution systems. ITC does not own distribution systems.
Technically, ITC is an electric utility. But unlike most utilities, ITC has rates that are regulated by the Federal Energy Regulatory Commission (FERC), not state utility commissions. Rates are one reason why investors should like ITC. In theory, ITC should never lose money, because FERC sets rates on the basis of costs, plus a modest markup.
ITC, which has a market capitalization of almost $4 billion, is a mid-sized utility and getting larger. Since 2005, it has had a 22% compound annual growth rate in earnings, and it has increased its dividend each year. The executive team is focused on growth.
Originally, ITC was DTE Energy's (DTE) transmission-line subsidiary. As part of restructuring, DTE and other Michigan utilities were forced to divest their transmission-line assets. In April 2004, DTE sold ITC to KKR & Co. (KKR) and Trimaran Capital Partners for $610 million. In 2005, ITC became a publicly traded stock.
In 2006, ITC bought Michigan Electric Transmission Company. CMS Energy's (CMS) transmission systems were included in that deal. Combining METC's and DTE's transmission systems gave ITC virtually all of lower Michigan's transmission assets.
In 2007, ITC bought more than 4,500 miles of transmission lines from Alliant Energy (LNT). Renamed ITC Midwest, that division currently operates transmission services in Iowa, Minnesota, Illinois and Missouri.
In 2007, ITC formed ITC Great Plains to build, own and operate transmission lines in Kansas and Oklahoma. Those lines have been approved by the state regulators and FERC. ITC Great Plains is currently constructing several major transmission lines, estimated to cost some $475 million, which will tie the existing Kansas power grid to wind farms in western Kansas and to the transmission grids in Oklahoma and Nebraska.
ITC is about to take another big leap. Last December, Entergy (ETR) announced that it planned to sell its entire electric transmission business to ITC -- this would be a divestiture of some 15,700 miles of transmission lines that crisscross the South and parts of Texas.
The divesture is not a done deal. As Duke Energy (DUK) and Exelon (EXC) learned, acquiring multi-state utility systems can be a difficult process. The deal requires the approval of FERC and state utility regulators in Arkansas, Louisiana, Mississippi and Texas, as well as the New Orleans City Council. ITC shareholders also must approve it.
This divesture would be complex. According to ITC, the agreements call for Entergy to divest its electric transmission business to a newly formed entity, Mid South TransCo LLC, and distribute this newly formed entity to its shareholders in the form of a tax-free spinoff. Mid South TransCo would then merge with and into a newly created merger subsidiary of ITC in an all-stock, reverse Morris trust transaction -- a deal that combines a spinoff with a merger in order to allow a tax-free transfer of assets.
Prior to the merger, ITC expects to effectuate a $700 million recapitalization, which is currently anticipated to take the form of a one-time special dividend to its shareholders. The merger would result in shareholders of Entergy receiving 50.1% of the shares of pro forma ITC in exchange for their shares of Mid South TransCo. Existing shareholders of ITC would own the remaining 49.9% of the combined company. The transaction is expected to be immediately value-accretive to ITC shareholders.
If ITC can complete the deal, it would emerge as a giant in the transmission-line business. It would own transmission lines from Michigan to Texas. Because its assets are rate-based, all of its lines should remain profitable. And in all likelihood, the Entergy deal would not be its last acquisition.